Will India’s stock market become less volatile?

An inflow of capital from domestic investors should help to temper global sentiment-driven volatility. 

The latest victim of emerging market panic has been India. Over the past month the country’s two main indices, the BSE Sensex and the NSE Nifty 50 have each dipped by around 6 per cent.

Driving this downward trend is the increasingly negative outlook on emerging market among investors. This summer’s currency crisis in Turkey sparked contagion fears, prompting India’s rupee to fall to a historic low against the dollar in August. Compounding this, investors have been further spooked by the rising price of oil, leading to a widening of India’s current account as the country is a major importer of the commodity, which looks more expensive in dollar terms as the rupee falls.

But while overseas investors may feel less positive about the outlook in India, David Cornell, manager of the India Capital Growth fund, says a growing number of domestic investors are providing welcome capital to the country’s stock market.  

The number of domestic investors is growing for a number of reasons, not least the attempts by prime minster Narendra Modi to clamp down on corruption. The government’s ‘demonetisation’ policy in 2016, which took large bank notes out of circulation, has helped ease a ‘savings under the mattress’ culture.

At the same time, the Real Estate Act (also passed in 2016) and restrictions on gold imports since 2013, have discouraged other traditional forms of savings. ‘There has been a push of savings into the formal financial system from multiple angles,’ says Cornell. Much of this money has been invested in India’s markets, via a formally recognised vehicle called a SIP (Systematic Investment Plan).


The growth of domestic fund flows over the past two years can be seen in the chart above. Inflows from overseas investors (represented by the grey line) have ticked up slightly but with a number of large swings along the way. Meanwhile, inflows from domestic investors (the blue line) have steadily increased, with much less volatility. 

The difference in sentiment between Indian and overseas investors is particularly obvious between September 2015 and February 2016, when the two lines start to move in separate directions. At this point, overseas investors were selling out of India as concerns loomed about a slowdown in emerging markets, particularly China. However, domestic investors largely stayed put.

Domestic and global sentiment once again diverged in late 2016, following the election of Donald Trump in the US. Once again, oversea investors lost their nerve while domestic investors stayed their course and ignored global noise.

‘This local support in the market has reduced volatility, which in due course will further increase the attractiveness of Indian equities due to superior risk-adjusted returns,’ explains Cornell.

There are several potential reasons for this. Despite what portfolio theory and other ideas of asset allocation say, most investors keep a home bias. While global investors may calculate that certain risks require cycling funds out of one region into another, for domestic investors the home market remains the primarily place to invest.

Alternatively, the lack of market withdrawals among India’s could be a sign of ‘less sophisticated’ investors simply ignoring risks. Just as Chinese investors have been accused of doing, Indian investors could be seen to be bidding up prices speculatively, viewing investing more as gambling.

But Cornell thinks this view is mistaken. Retail investors buying into the market through SIP investment vehicles, he says, are ‘very different to the “hot” short-term trading culture that is often attributed to Chinese domestic investors’.

Cornell adds: ‘It is worth noting that domestic investors in India are being guided by a strong equity culture, in a country which has five thousand listed companies, and Asia’s old stock exchange in Bombay.’

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